CHICAGO -- Detroit’s proposed $350 million debtor-in-possession financing, while rare in Chapter 9, is not the first such deal.
The honor goes to Orange County, Calif., which 18 years ago completed a pair of DIP financings that were key to lifting the county of its bankruptcy.
“Most people have forgotten Orange County,” said Roger Davis, public finance chair at Orrick, Herrington & Sutcliffe, which acted as underwriter’s counsel on the OC deals. “Detroit is certainly bringing them up to date. When people look at whatever the next municipal bankruptcy is, they’re going to look at Detroit and Orange County.”
The two governments suffered very different problems that drove them to file for Chapter 9.
But their DIP loans share many of the same features and will, if Detroit is able to close its $350 million loan with Barclays, mark the largest such financings in Chapter 9.
“This [DIP loan] seems to be critical for Detroit,” Davis said. “More likely, they’ll do some more financings as part of their emergence from bankruptcy.”
Orange County filed for Chapter 9 after suffering $1.7 billion of losses in the Orange County Investment Pools. The losses were aggravated by the county’s budget shortfall due largely to the loss of interest income from the failed investments.
“Our bankruptcy was a little different from Detroit’s,” said John Moorlach, OC’s treasurer during the bankruptcy who played a key role in the county’s financial recovery. “Detroit’s is the issue of spending a little more than you make every year, while Orange County was like a hedge fund implosion.
“Our big focus was trying to address those losses, and deal with all the schools and cities [who lost money] in the investment pool and get the rest of it from litigation,” said Moorlach, who is now a county supervisor. “That was our approach to our plan of adjustment, and it was key to getting the deals done.”
Orange County completed two DIP financings in 1995. A $279 million recovery bond sale featured a super-priority lien that allowed the county to pay off the school districts that had suffered investment losses. Proceeds from the deal financed a settlement between the county and the districts that was reached in bankruptcy court.
Like Detroit’s deal, the county’s $279 million of recovery bonds relied on an intercept feature, which allows the bond trustee to collect the revenue backing the bonds directly for debt service before passing the remainder on to the government.
Both governments sought bankruptcy court approval for the deals, a key to DIP financings.
Both also featured super-priority liens, making the repayment of the debt superior to all other creditors and administrative costs.
“Orange County provided two very useful models for how you might do DIP financings, and at least one of them is being replicated in Detroit,” Davis said. “One is a settlement with some of the creditors, which is essentially what Detroit is doing,” said Davis, referring to the city’s proposed settlement with its interest-rate swap counterparties, who would be paid with part of the proceeds of its $350 million deal. “The other is getting some assets out of the bankruptcy estate that would enable them to borrow.”
The second model is the one the county used in issuing $150 million of so-called Teeter Plan revenue bonds backed by delinquent property taxes in 1995. The county set up a separate authority that was outside the bankruptcy to take over the delinquent tax assets.
OC’s recovery bonds were backed by all available funds of the county and additionally secured with motor vehicle license fees. The recovery bonds were also insured by MBIA Insurance Corp. The county paid interest rates of between 5% and 6.10% on the debt, which was sold in the public debt markets -- unlike Detroit’s plan.
“Orange County was an essentially wealthy community that had the ability to pay [the recovery bonds] back, and in that case they’re significantly different from Detroit,” Richard Ciccarone, chief research director at McDonnell Investment Management LLC, said. The MBIA insurance also smoothed the way for that deal, said Ciccarone.
Willkie Farr & Gallagher was bond counsel on OC’s deal in 1995. Goldman, Sachs & Co. and A.G. Edwards & Sons, Inc. were the underwriters. Orrick, Herrington & Sutcliffe was the underwriters’ counsel. Salomon Brothers was financial advisor on the deal.
The county also issued certificates of participation backed by the county’s real estate in 1996 as it emerged from Chapter 9. All the financings were considered key to the county’s long-term recovery plan.
Orange County’s 1995 recovery loans were sold with a final 2015 maturity. They were refunded in 2005.
Detroit’s loan is for 2.5 years, or when the city emerges from bankruptcy.
Detroit is hoping to close on its $350 million DIP loan with Barclays by the end of the year. Detroit’s DIP features pledges of the city’s casino and income tax revenues. The agreement calls for the city to pay Barclays roughly $4.3 million in commitment fees and a floating interest rate based on the London Interbank Offered Rate plus 3.5%.
Several of the city’s creditors, including bond insurers and unions, are fighting the deal, saying it would take too much of the city’s revenue off the table. A hearing is set for Dec. 10.
Whether DIP loans are a good idea in Chapter 9 depends on the circumstances of the bankrupt government, according to bankruptcy attorney James Spiotto.
“If it has the money to keep operations going, or to do an improvement that’s necessary as part of their recovery plan, then it makes sense,” said Spiotto. “Obviously [Detroit officials] believe they need the money and it’s their determination that they need it to be able to continue to operate.”
While Orange County entered bankruptcy for different reasons than Detroit, the Motor City’s problems are now a kind of bellwether for cities across the county, especially in California, said Moorlach, a Republican.
“What’s really fascinating about Detroit is their issues are endemic of all municipalities today,” he said. “With Detroit, as with our two cities, Stockton and San Bernardino, it’s this slow process of running out of cash as you’re seeing your fixed costs increase while revenues are stable or decreasing.”
Moorlach said he’s a “big fan of Chapter 9” for the way it helped the county work out its problems and was key to its restructuring plan.
“You go into bankruptcy court to get some debt relief, but the tumor for everyone now is the pension plans,” said Moorlach. “OC didn’t have a problem with its pensions -- in 1994 it was just a hedge fund implosion -- but everyone has that problem now. It’ll all grind to a halt when investors say, You’re not paying us enough to take on the risk.’”